A Buy-Sell Agreement (“Agreement”) is a contract between the owners of a business and the entity, for the owners to sell and the business to purchase their business interest (e.g., shares, stock, units) at a pre-determined price if future events occur, such as retirement, death, disability, outside party purchase offer, termination of employment, or divorce. An Agreement can help to assure a smooth transition for the entity, the remaining owners and departing owners. It protects an owner’s investment in the business so that if he or she leaves the business, is disabled or dies, s/he (or heirs) will get what is fairly owed.
An Agreement also helps to assure that the remaining owners will not be required to be in business with someone they do not know or trust or someone they do not want to be in business with, such as a shareholder’s angry ex- spouse or irresponsible child. The owners will also not be compelled to negotiate the terms of a buy-out under stressful circumstances, perhaps making unwise concessions, or to come up with a large amount of cash unexpectedly to buy someone out, distressing the company and its cash-flow. If all owners understand what happens on their departure ahead of time, the ongoing relationships among the owners may go more smoothly. An Agreement may help to avoid costly litigation and aids responsible estate and tax planning.
If a predetermined formula for the purchase price is set, it can prevent the dilemmas that arise when the remaining owners must negotiate price and terms with the family of a deceased or disabled owner, and this is one less worry for everyone involved during a very stressful time. This also helps avoid an unfairly inflated or deflated value due to temporary business or market conditions. It is also smart to plan how the purchase price is to be paid, whether from a company-owned life insurance policy, over time with regular payments with or without interest, or in a lump sum.
Agreements are tailored to the needs and wants of each individual business and its owners; there is no set form, which allows business owners to tailor this process to their needs and business culture.
Among possible triggering events to consider:
- Sale of stock to unknown, unwanted or adverse third parties or creditors
- Transfers that would cause the termination of a company’s “S” tax election
- Death or disability of an owner
- Divorce of an owner
- Termination of employment of an owner
Among the main issues that can be addressed:
- Events that would trigger a buyout
- Formula for establishing a fair purchase price, e.g. independent appraisal, fixed amount
- Structure so tax treatment can be most advantageous
- How the interest will be funded, e.g. life insurance, long-term financing structure
- Rights among the remaining owners to purchase the interest of the departing owner
- Settlement of personal loans, guarantees, leases, etc. from departing owner to company
- Dispute settlement arrangements
While it may be uncomfortable to address these issues and contemplate possibly sad circumstances, it is far better to have an Agreement in place that will make it easier on the company and all parties when a transition occurs than to have to deal with it unexpectedly without a plan.
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